Business

Copyrights, Royalty Splits & More: 'Ruthless' NFT Market Sparks New Legal Debates

Getty Images

On April 26, an NFT of a Jean-Michel Basquiat drawing popped up on the marketplace OpenSea with the promise that the winning bidder would be granted copyright ownership of the work and the option to destroy the physical original. But after Basquiat’s estate intervened, confirming that the seller held no rights to the drawing, the NFT was removed within 48 hours.

The kerfuffle reflects confusion over how the rapidly growing artistic medium fits into existing copyright law -- an especially thorny space to navigate for NFTs involving music, given the music industry’s complex web of rights-holders. As artists and executives are clamoring to strategize how best to approach the emerging market, then, so are their lawyers.

Lawsuits are "coming," says entertainment lawyer Jordan Bromley, who leads the entertainment transactions and finance practice at Manatt, Phelps & Phillips, LLP. "The number of threats being made of litigation is astounding."

To begin with, artists who want to use music in an NFT but don’t own all the recording and publishing rights must identify the relevant music licenses and then get those licenses from rights-holders. This is an obvious step for lawyers like Bromley, but it’s an easy one for artists to gloss over in the rush to capitalize on the NFT market.

"Any time a client asks me how this works, I tell them to start with, 'What are you making?'" Bromley says. "All sorts of licenses are implicated, depending on what you’re doing."

If an NFT consists of a clip of music played over a video or graphic, for example, the creator needs a synchronization license to marry the audio with video (usually from a publisher) and a master license to reproduce the song recording (usually from a label). Both licenses are non-compulsory, meaning that the rights-holder has free rein to choose their price or refuse to grant a license at all.

Music attorney and LaPolt Law founder Dina LaPolt says that NFT creators must also clearly explain what the buyer is actually purchasing, as there is a common misconception among new collectors that purchasing an NFT means assuming ownership of the underlying copyright and intellectual property.

"The buyer pays a substantial amount of money for this NFT, and if they think they own the underlying intellectual property embodied on the NFT, that’s going to be an issue," says LaPolt, whose law firm represents deadmau5, who has sold more than $1.7 million in NFTs across several drops since December. "The terms of service need to be very, very specifically drafted."

Unfortunately, the same qualities that make the blockchain appealing -- it is decentralized, anonymized and global -- will make enforcing copyright law a challenge.

"You can’t call somebody who’s the CEO of the blockchain and have a transaction shut down," says Brian Korn, partner of Manatt Financial Services who leads the firm’s fintech practice. "It’s a much more ruthless environment."

If an artist believes their work has been used in an NFT without permission, they have the burden of tracking down the holder of the “smart contract” attached to the NFT, which contains lines of code that automatically execute behaviors (such as where revenue should flow). But that’s no easy task in the anonymized world of blockchain, where buyers and sellers are typically known only by their usernames and could be located anywhere in the world.

"The chances of you being able to locate and get cooperation from someone are difficult," Korn says. "If you find that the end of the trail is an IP address in North Korea, good luck."

Rights holders who believe their work has been used in an NFT without permission can usually file a report with the NFT marketplace host, after which the marketplace will investigate the issue and remove the NFT if it is found to be infringing. In their terms of use, the marketplaces currently do not assume responsibility for copyright infringement by users, but that could change. "As these spaces get more and more regulated, there is a risk that there will be additional scrutiny on them," Korn says.

Even if licensing the music to create an NFT is a fairly straightforward process, Bromley says, things get complicated when it comes to divvying up the sale profits. So far, most creators are carving out 50% of revenue to the visual art and 50% to the music, which is divided amongst various rights holders from there. But recording and publishing deals complicate this further.

Artist lawyers like Bromley and LaPolt argue that because collectors are primarily motivated to buy an NFT based on the name or brand associated with it, which translates to a higher resale value, the music and visual artists at the center of NFTs deserve the lion’s share of the revenue -- not the label.

"The bigger the brand, the more successful [the NFT] is, not because people want to listen to the music but because they think they can get a higher price when they resell it," Bromley says. "It would be unfair to the releasing artist to not attribute a portion of the profit to the brand name itself."

There are many possible ways to reflect this in the revenue splits. Out of the 50% of total revenue allocated for music, 25% could get carved out for all the rights-holders (including the publisher, label and artist), with the remaining 25% going straight to the artist for their brand. Alternatively, LaPolt suggests that creators could allocate a third of the total revenue from an NFT to the music artist, a third to the visual artist and a third to the music copyright holders.

In her experience thus far, "nobody has come with a heavy hand," from the label side, LaPolt says. "But I don’t really give them much to negotiate."

Bromley is confident that the lingering issues with NFTs will work themselves out in time, and notes that it doesn’t make sense to have a market solution across all NFTs anyway. "It really is case-by-case, because they’re all so unique and different," he says.

On the positive side, "It’s something new that we can put brainpower into," he adds. "We do 1,000 producer deals a year; [NFT]s are new, unique and exciting."